The company recently took a big step toward rounding out its digital-chip product offering when it licensed the MIP32-4Kcsynthesizable processor core from MIPS Technologies Inc. The license, ESS said, has helped the company expand its chip applications beyond its mainstay audio business to meet the rapidly growing consumer-applications demands that require the latest in digital technologies.

"Now, we can offer an architecture with a MIPS CPU combined with our existing entertainment-feature applications, such as a DVD controller for the Internet-appliances or Internet-computer markets," said Robert Blair, president and CEO.

A MIPS license was essential for ESS to remain competitive in the
digital-applications market, according to analyst Jay Srivatsa of Dataquest Inc., in San Jose.

"The main reason for ESS licensing MIPS is to have a complete back-end solution for DVD players and digital set-top boxes," Srivatsa said. "Their current MPEG solution needs an external CPU, which puts them at a significant disadvantage relative to other companies such as IBM, LSI Logic, and STMicroelectronics, which have integrated a CPU with their MPEG-2 decoders. My read is that ESS really did not have a choice but to license a CPU core in order stay competitive in this arena."

Like other traditional PC audio-chip vendors, such as Yamaha Systems Technology and Philips Semiconductors, ESS has sought to recoup margins that have suffered as software-based audio technologies have emerged to replace PC-audio applications.

"We've had a great run in audio, which still remains a big business for us today, but we know that it's not going to be here forever," Blair said. "At the same time, the markets we've entered are going to let us expand into the Internet, computer, broadband communications, digital video, and combinations of these technologies. We've determined the technologies these new markets will require, and now it's up to our marketing people to
figure out how to mix and match them."

The company's pure audio-application sales will for the first time represent less than 50% of its revenue in 2000, Blair said.

This year, audio will represent 25% to 30% of revenue, digital video will be roughly 40%, and the balance will be in the communications and Internet-appliance markets, according to company estimates. In 2001, audio revenue will be down to about 10%, with digital video hovering at 40%, and communications and Internet appliances constituting the remainder, Blair said.

Prior to obtaining a MIPS license, however, ESS' digital business had
already generated strong sales and high margins, especially in China,
which has leap-frogged the analog-VCR market to adopt MPEG-1 VCRs. The country also has a huge DVD market that Blair says outnumbers the U.S. market by a factor of 10, with 35 million DVD players sold there last year.

ESS has already shipped MPEG-enabled set-top boxes, which could also use the new MIPS core, to China through a wholly owned subsidiary, ViAlta.com.

"We currently have between 50% and 60% market share in the DVD
Chinese market, which we entered during the 1996 Christmas season," Blair said. During the fourth quarter of 1999, the company shipped more than 500,000 DVD units to China, making ESS the largest supplier of digital-video chips as well as audio chips to that country, he said. Blair maintains, however, that the company is not ignoring audio applications, especially in the notebook and retail-PC markets.

"Notebooks still require audio features that aren't yet available in
core-logic chips," Blair said. "In the retail market, there's strong consumer demand for $500 to $600 PCs with audio-chip sound cards for an additional $100. In the inexpensive-PC market, consumers have the best of both worlds because they're getting a good gaming solution at a relatively low price."

ESS' drive into digital-consumer applications took on a broader focus earlier this year, when the company acquired NetRidium Communications Inc., a privately held developer of technology for broadband communications over home phone lines.

Earlier this year, ESS reported 1999 revenue of $310.7 million, an
increase of 42% from 1998 revenue of $218.3 million. Net income for the year was $40.1 million, or 88 cents per share, compared with a net loss of $28 million, or 68 cents per share, in 1998.